The impact of the Fed’s 1st interest rate cut in more than a decade

Late last month, the Federal Reserve cut interest rates for the first time since 2008, when the country was beginning its submersion into the Great Recession.

The Fed cut rates by a quarter-point, this time as a preemptive measure rather than a recovery tool. Their aim is to encourage domestic investment and spending in order to help sustain the nation’s current economic momentum and curb any potential global economic downturns.

Although the Fed dropped the rate from 2.25 to 2 percent, President Trump and markets hoped for more. Due to concerns of sluggish economic growth in China and Europe, in tandem with the U.S.’s trade war with China, the S&P 500 slid 1.1 percent on the day of the announcement.

“The rate cut was only 0.25 percent so its impact on consumers and the economy probably won’t be very significant,” American Enterprise Institute scholar Mark Perry said. “But for borrowers, the rate cut might help with lowering borrowing costs in the short run. For example, the 30-year mortgage rate fell [August 8th] to 3.6 percent, the lowest level since November 2016, and down from 4.59 percent a year ago. So for potential home buyers, or for existing home-owners looking to refinance, the rate cut could translate into lower monthly payments. Likewise, for car buyers, the rate could translate into lower car payments.”

Perry notes that hopefully this policy was made because of market forces rather than political pressure. Local economist Jim Rounds had a different opinion.

“It’s very unusual when the economy is doing well to cut rates. My gut feeling is that politics is playing a role with these said decisions, because from an economic perspective, these rates would not have been cut yet,” Jim Rounds said. “We still have a stock market that is doing quite well despite the movement from today. I know that a lot of people are calling for this, but again, you would typically see these reductions when they would have a bigger impact.”

Two Federal Reserve officials – Bank of Boston’s Eric Rosengren and Kansas City’s Esther George – both voted against the decision to cut rates. And with the unemployment rate at a historic low and a subsequent rise in wages, their reluctance is justified. Generally, rate cuts should be employed only under dire circumstances, Rounds said.

“If you don’t have the ability to add extra money into the economy bouncing around for all the different mechanisms from a rate reduction – if you don’t have as much of an opportunity to do that in a downturn, then the downturn is going to be a little bit worse than it would have,” Rounds said. “What we did is we kind of took a bucket and scooped some of the economic activity from the next downturn into the current expansion. That means the current expansion, possibly, could be slightly stronger but not noticeable in the numbers — but the downturn could be worse. You want things to be more smoothed out, which is why we have the system.”

Nevertheless, the rate cuts do have short-term advantages for consumers, who are able to invest and borrow at lower interest rates. As long as this doesn’t spark a policy domino effect of precautionary interest rate cuts, this won’t have a pernicious effect on the economy, according to Rounds. “It’s like anything else, if this continued for a while, you have negative effects. If it’s just one change in the rate, it’s not going to matter a whole lot long-term,” he said.

“It should be noted that low interest rates are really only good for half of the credit market – borrowers, and are really bad for the other half of the market – savers,” Perry said. “Lowering interest rates helps borrowers and harms savers, with no overall positive effects – the effect is neutral. You can help half of the participants in the credit market (borrowers) and harm the other half (savers) on a one-to-one basis, and think the overall effect will be positive. It won’t, it will be a win-lose, zero-sum outcome.”